Mike Krigsman over at ZDNet and the IT Project Failure blog wrote Friday about Levi Strauss’ recent disclosure of a major SAP implementation clusterschmuck. These problems caused Levi Strauss to stop shipping for a week and resulted in a 98% drop in net income relative to the same quarter last year.

Mike described the relationship amongst the client, the software vendor and the systems integration partner this way:…Virtually all large ERP implementations involve three parties, which I call the devil’s triangle: software vendor, customer, and at least one third-party implementation services provider.

The complex and interlocking set of business and technical agendas governing these relationships can make failures difficult to dissect accurately. Of course, the parties usually don’t want to discuss their failures in detail, which also makes full analysis hard.

I would add one more important party to this relationship, the external auditor. In this case we’re talking about PwC. And it was PwC that brought the hammer down on Levi Strauss. Mike asked me to explain the disclosures included in the SEC 10-Q filing that blamed the drop in income on the ERP implementation failure.

My quote:

It’s serious stuff. The language suggests that fundamental internal control errors were discovered after the system went live. Apparently, auditors determined these problems could have resulted in a materially significant impact to Levi’s financial statements if not corrected. I can speculate that perhaps it was inventory related, because [inventory] is the big balance sheet item for a company like this.

Also, given Levi’s previous errors and restatements, and with the recent change in auditors, new auditor PwC is probably taking a very strict approach to assessing Levi’s efforts to implement SAP with required controls.

I also told Mike:

Multinationals have long struggled with getting an ERP implementation right in one country on the first go around. When they implement multiple instances in quick succession, they accept the challenge of automating manual processes, adding automated controls to those new processes, and making these new and improved processes conform to the software capabilities and their business objectives. That’s almost impossible to get right the first time.

After thinking about it a little more over the weekend and tapping into some sources at PwC, Levi Strauss’ auditor, I would also say this:

My sources at PwC reminded me that this situation is common and not, obviously, a good thing. Many companies don’t really realize the impact a new ERP is going to have across the whole enterprise. Therefore, many areas are not taken seriously or adequately planned for from a time or budget perspective. Just look at PwC’s own implementation of SAP, using their former consultants who were now working for IBM. A go-live date was set and it happened, even though much of the work was left to be done afterward, without the support of IBM.

Internal controls should be front and center now due to Sarbanes-Oxley, but instead they are most often left on the back burner, not on the sponsors’ and steering committee’s radar screen.

The main reason this happens is because companies always look to their consulting vendors for advice and those consulting firms (Accenture, BearingPoint, CapGemini, etc.) have business process re-engineering with the use of technological components (ERP’s, e-business apps, etc.) as their main focus . They are not in any way, shape, or form experts on internal controls. Even when you use Deloitte Consulting, you’re using the consulting folks, not the audit folks. As close as they are, there are very different kinds of people, at least in Deloitte, on either side.

Therefore, companies constantly make the mistake of thinking that if the consulting firm in charge of the implementation doesn’t consider internal controls as an important part of their implementation, then maybe they don’t have to focus on them to the extent that they should be focused to get them right.

Those that work on internal controls at any company know how important this focus is. Are those folks, from internal audit and/or the internal controls SMEs, included in the project team? Can they influence project planning?

At some point in the implementation lifecycle their message gets lost. Upper management takes a stronger stance in regard to their critical path (Purchasing, MRP, Sales and Distribution), meeting the milestone dates and meeting budget goals. These timelines and budgets most often did not include enough time or money for internal controls work. This is no different than what also happens during many ERP implementations to other “soft” activities like HR and staff redeployment, training, documentation and manuals, and change management.

These issues have evolved over the years. If we look back to the early stages of ERP’s, the main focus was Production Planning, Purchasing, Warehouse Management (materials management), Accounting (Financials) and Sales and Distribution (Logistics). All other areas really weren’t taken seriously and in their time they had the same problems that Compliance is having now. As the ERP’s evolved, they started including other applications such as CRM, SRM, Business intelligence (Strategic Management reporting), amongst others. Now vendors are at the Compliance stage of their maturity model, which means that they’re now focusing on creating compliance applications to make internal controls and reporting a lot easier. (e.g. SAP – GRC Suite and Approva BizRights)

These compliance applications have now been implemented in many companies worldwide and work relatively well. Of course, it would be great to see everything fully automated, but it is a major improvement over establishing, testing and reporting results of controls using spreadsheets (controls matrices.)

Levi Strauss should immediately hire an accounting firm (or an internal controls focused professional services firm such as Protiviti) to do a Quality Assurance review of their implementation focused on their internal controls requirements.

Indeed what a “mess” but the whole ERP message is fundamentally flawed – it is basically an accounting system that records history and manipulates information. They are not people friendly where all information is created in a dynamic environment. ERP may “square the books” but does little to improve competiveness or efficiency. In this dynamic people environment you need very agile software that can change as the business changes – quite different from ERP. Software vendors have failed to solve this problem so people use spreadsheets off line data bases etc anything but whatever all sit in unstructured and uncontrolled envireonment = high risk. Where are the auditors? 35+ years ago as a trainee accountant I was doing audits looking at systems end to end picking up weaknesses and focusing as required – then computers arrived. Great st “processing power” and keeping records but failed to get to business fundamentals. So scandals and fraud continue and we all pay the price. Stop spending money on updating “general ledgers” spent it on truly uniting people and their processes that make or break any business – as for auditors they also need to get back to basics ……

Levi’s never took care of their own accounting dept. There was alot of turnover there and much of the work was being handled by temps or admins or interns. And the ones who knew what they were doing were overworked and few and far between. Also they did not want to fork over the extra money for someone to do the job right. It was cheaper to take a risk.

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Francine McKenna (@retheauditors) is the Transparency Reporter at MarketWatch.com, a Dow Jones publication, where her work is also featured frequently in the Wall Street Journal. McKenna had more than twenty-five years of experience in consulting and professional services including tenure at two Big 4 firms, both in the US and abroad before becoming a journalist. Look for her prior columns, "Accounting Watchdog" at Forbes.com and "Accountable" at American Banker. For more information, click "About" at the bottom of this page. For more information contact Francine McKenna, fmckenna@mckennapartners.com